How to Save for Your Kids’ College Years Without Bankrupting Yourself

Do you know what it costs to go to college these days? If not, you should probably sit down for this.

A two-year degree costs more than $3,600 per year on average, according to a College Board analysis of published tuition prices for the 2018-19 school year.

A four-year degree from a public school? You’re looking at over $10,000 per year.

And — take a breath — a private-school degree? $35,830. Every year. For four years.

And that’s just the average.

If you’re thinking ahead about the cost of sending your child or grandchild to college, I realize I may have just sent you running for a paper bag to gasp into.

Whether it’s community college, a state school or the Ivy League, higher education is costly. Americans have more than $1.5 trillion in student loan debt to prove it.

And all that debt has left most parents to wonder: Where are tuition prices going to go from here? While data shows college prices aren’t rising as quickly as in previous years, no one can be sure.

But if you use these strategies to prepare for their college years, you can figure out the best way to support your favorite student financially.

Determine What You Can Afford to Contribute and When

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You’ve probably dreamed of the child in your life leaving college with a quality degree from a great university and zero debt. It might even be why you’re reading this right now.

But it’s important to not let that dream lead you astray.

Instead of asking yourself what you should or need to contribute, ask yourself what you can contribute.

We all know the earlier you begin to save, the better off you’ll be.

But if you’re behind where you’d like to be, you should be careful of how aggressively you try to make up ground.

Peter Magnuson, an independent financial advisor in Sarasota, Florida, says it’s important to note that you’ll spend a lot more years in retirement than your child will spend in college. “Would you fund this over funding your retirement account in a healthy and appropriate way?”

Magnuson has seen many parents take on heavy financial burdens for their children. He’s seen clients, determined to cover all costs for multiple children, still working with little savings in their 70s, despite considerable earnings.

Try not to think about saving for your child’s college education in a silo. Instead, think of it alongside your other financial goals.

Tackle high-interest credit card debt before thinking about your children’s futures. Then prioritize your retirement savings. Remember that your kids can take out loans and get scholarships to help with school costs, but you can’t take out loans or get scholarships when you’re ready to retire.

If you’re confident the rest of your budget is healthy, you can start adding college savings to the mix. But you don’t have to plan to cover every dollar of your child’s education.

Even if you start when your child is 10 years old and put away $100 per month, you could save at least $9,600 to contribute toward their education by the time they go to college.

Play with acollege savings calculator to determine what’s reasonable for your family, and remember that you can always adjust how much you choose to save over time.

5 Common Ways to Save for College

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Once you’ve determined how much you can afford to contribute, you’ll need to know where to put that money. The ideal place for you will depend on whether you’d prefer to play things safely or assume higher risk for the chance of higher returns.

Here are some pros and cons to the most common options.

Traditional Banking

If you are over 18 in the U.S. and do not have checking or savings account already, you are in a serious minority.

Pro: Your savings in these accounts are insured by the Federal Deposit Insurance Corporation (or the National Credit Union Insurance Fund, if your account is through a credit union) up to $250,000. This means that your savings are protected from the volatility of the stock market.

And you can usually take advantage of promotional offers that will earn you cash back or bonus points just for opening a new account.

While according to the FDIC the average interest rate on savings accounts at U.S. banks they insure is 0.09%, high-yield savings accounts have gained popularity in recent years.

You also have the option of investing in certificates of deposit, or CDs. With these certificates, you put down a deposit at a commercial bank, and the bank pays you interest over a fixed period time, after which you receive your full deposit back.

The interest you receive from CDs is usually no more than 2%.

Con: Even 2% is very far from most investment targets. To give you some perspective, the S&P 500 — a stock market index that tracks the stock value of 500 companies designed to represent the market as a whole — has returned at least 10% in five of the last seven years.

So while your money would have been safe from the 4% loss the index saw in 2018, you also would have missed the almost 22% return of 2017.

For short-term savings goals, it might be best to avoid the possibility of a market downturn. But if you’re investing for the long-term, the market will provide much more interest.

529 Plan

If you want your interest to go further, one option you have is the 529 savings plan. Offered in all 50 states and Washington, D.C., these plans are available for anyone to open and contribute to.

The accounts are exempt from federal income tax as long as you use the withdrawn cash for tuition or room and board.

Pro: When you open a 529 savings account, your money gets invested in a portfolio of your choice, same as how you’d manage a 401(k). While your options will vary based on the institution, you will commonly have access to mutual funds, exchange-traded funds and target-date portfolios.

What this means is that your returns will more closely mirror the market.

And in most states, you’ll receive an income tax deduction or credit for contributions you make to the 529 plan.

Con: The downside of a 529 savings plan is that it can only be used for college expenses. If your child ends up not attending a postsecondary institution, you can name someone else as a beneficiary — or even use the balance for your own education.

But if you take the cash out for any reason other than postsecondary education, you’ll pay federal taxes on the amount withdrawn plus a 10% federal tax penalty.

529 Prepaid Tuition Plan

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A second kind of 529 plan allows parents and grandparents to lock in today’s tuition rates at participating universities in your home state.

Pro: In most cases, the state will guarantee that the funds you contribute keep up with tuition costs, which means your investment is insured in the event the fund underperforms.

Magnuson encourages his clients to consider this option. “If you can afford to make that payment, your child at least has the ability to get a four-year degree,” he said.

Con: Typically, while you will not lose everything in the fund if your child chooses to go to an out-of-state institution, you will not get the full balance. You also must be a resident of the state with which you have the plan.

So if your child or grandchild knows they want to go to an out-of-state school, this will likely not be a good plan for you.

UGMA and UTMA Accounts

These accounts were developed in the mid 1950s and revised a decade later. Both were subsequently named after the legislation that established them. The Uniform Gift to Minors Act and Uniform Transfer to Minor Act both concerned the transfer of securities.

The result of their passage was the creation of custodial accounts that allow a gift giver to invest and manage funds until a minor reaches a certain age, at which point control of the funds are transferred.

Pro: There are no restrictions on what the child can use the money for. So if you simply want to provide a nest egg to help them start their adult life — whatever that may look like for them — this freedom can be attractive.

And since the money will be under the child’s name, a percentage of the earnings will typically go untaxed.

Con: For UGMA accounts, control of the account is given to the child at 18. For this reason, the accounts tend to draw criticism. Magnuson says they are the only saving option that he would discourage investors from considering.

That’s because, in the event of poor life decisions, large sums of money under the control of an 18 year old can be a dangerous thing. And as a parent (or grandparent), you will not be able to intervene.

“All you can do is throw a play in from the sideline and hope that someone runs it,” Magnuson said.

UTMA accounts usually transfer at the age of 25. Because of this, some find them to be a preferable option if they are wanting to go the custodial route.

Ultimately, you’ll have to assess your own level of comfort if you’re considering this option.

General Investing

You’ll notice that the downsides of the investment options up to this point have largely had to do with restrictions that these accounts place on distributions.

These restrictions can be avoided if you choose a more traditional investment vehicle, such as an index fund or exchange-traded fund.

Pro: With these investment vehicles, you’ll receive the same tax-deferred benefits as you would with a 529 plan.

Magnuson says that families of considerable means can receive some special benefits from choosing a 529 plan, but for most of us, it can tend to overcomplicate things.

“Most of the time what my advice would be for what I would consider the rank-and-file people is just focus your life on saving money,” Magnuson said. “And as you accumulate wealth, yes, you realize [that college will be] a potential issue coming up down the road, but you’ll address it when the time comes.”

Magnuson says that if you retrain your thinking this way, you won’t have to worry about unqualified distribution penalties. You’ll have complete control over your funds in the event that plans change and your child’s college situation looks different from what you had been expecting.

Con: When you open such accounts, your money manager will typically charge a fee of around 1% of your returns.

Understanding How College Savings Can Affect Financial Aid

Students mingle at the Marshall Student Center at the University of South Florida in Tampa, Fla. Tina Russell/The Penny Hoarder

Many worry — when decided on an investment vehicle — about the potential impact their savings might have on their child’s financial aid eligibility.

Financial aid eligibility is calculated by subtracting what’s called the expected family contribution, or EFC, from the cost to attend the institution. Your EFC is determined by a formula that takes your family’s income and assets into account — including any investments held by either parent or the child.

Some grandparents will open 529 accounts in their own name as a way around this. But there are also consequences to that method: Any withdrawals given to the child from the grandparent’s 529 plan must be counted the following year as income for the student.

This will reduce the child’s financial aid eligibility by much more than a 529 plan in their family’s name. For this reason, it’s typically best to have a 529 plan in the name of the child or parent.

But even if you have your investment vehicle decided, you shouldn’t wait until the last minute to look into financial aid options.

Tips for Saving on College Tuition

It’s important to fill out the FAFSA — the Free Application for Federal Student Aid — even if you think you earn too much to be eligible.

The FAFSA is a gateway to consideration for grants, loans, need-based scholarships and even work-study jobs. It’s used at two-year and four-year institutions, and even some vocational schools.

Your estimated family contribution determined by the FAFSA may seem high, but it’s not an indicator for how much you’ll actually pay once aid has been granted.

As your child fills out college applications during their senior year of high school, encourage them to apply for scholarships, too. You don’t need straight A’s to be eligible for many awards, and there’s something for students in every course of study.

Talk With Your Child About How They Can Help

University of South Florida sophomore Sydney Bates, 20, studies for a test at the University of South Florida in Tampa, Fla. She saves money by eating at home or at club meetings when free food is offered. Tina Russell/The Penny Hoarder

A 2017 survey of nearly 2,000 parents by Fidelity Investments found that 72% of parents were saving for their children’s college educations. Parents planned to cover 51% of college costs from family savings.

That’s generous! But it’s not exactly optimistic. Still, 85% of parents expect their kids to graduate with student debt.

Start talking about college plans when your child enters high school. Ask them about their ideas, dreams and goals — and you should expect them to fluctuate during their teen years. Their career goals in ninth grade could be vastly different from their plans as they prepare to graduate high school.

During these conversations, be open about your family’s ability to pay for college.

Being honest about your financial commitment can help your child manage their expectations about college costs and what your family can afford to contribute.

Encourage your child to find part-time work to help save. Those birthday and Christmas checks, the tax refund check they’ll get from that job — every bit can get your family closer to your goal.

And if they need a little help, we might know a few ways the child in your life can make some extra money.

This article contains general information and explains options you may have, but it is not intended to be investment advice or a personal recommendation. We can’t personalize articles for our readers, so your situation may vary from the one discussed here. Please seek a licensed professional for tax advice, legal advice, financial planning advice or investment advice.